Spreads may widen due to several factors, which can be understood by revisiting some fundamental principles.
Liquidity refers to the ease with which a financial instrument can be bought or sold. Liquidity is determined by the volume of trades and the number of active participants in the market. Reduced liquidity can negatively impact order execution, resulting in longer processing times and increased spreads.
Situations that May Lead to Reduced Liquidity:
1. Macroeconomic Announcements: Events like the release of central bank interest rate decisions, inflation reports, PMI data, GDP figures, or speeches by central bank leaders (e.g., from the US Federal Reserve, Bank of England, Bank of Japan, and Swiss National Bank) often cause a reduction in liquidity.
2. Bank Rollovers: During the bank rollover period at 21:00 GMT in the summer (22:00 GMT in the winter, or 17:00 NY time), liquidity decreases as banks and ECN systems pause quoting and remove their orders.
3. Market Openings and Closings: Lower participation at the market opening on Mondays and the market closing on Fridays also leads to decreased liquidity.
Trading during these periods may result in undesirable outcomes, such as order slippage, where pending orders are executed at a different price due to changes during order processing. Occasionally, in extremely low liquidity, non-market prices may also appear.